C H A P T E R

1. C H A P T E R 5 Consolidated Financial Statements - Intercompany Asset Transactions

2. Intercompany Inventory Transactions • Transactions between the parent and subsidiary are viewed as “internal” transactions of a single economic entity. • The effects of those transactions should be “eliminated” from the consolidated financial statements.

3. Intercompany Inventory Transactions ENTRY TI On the consolidation worksheet, eliminate ALL intercompany sales/purchases of inventory. Purchases component of COGS.

4. Unrealized Inventory GainsYear of Transfer ENTRY G Despite Entry TI, ending inventory is still overstated by the amount of gain on the inventory that is still unsold at year end. We must eliminate the unrealized gain as follows: Ending Inventory component of COGS.

5. Unrealized Inventory GainsYear Following Year of Transfer ENTRY *G If the inventory was sold during the year, the gain is now in Retained Earnings and must be moved back to Income.

6. Unrealized Inventory GainsYear Following Year of Transfer ENTRY *G If the transfer of inventory is DOWNSTREAM & if the parent uses the Equity Method, then the following entry is used to recognize the remaining unrealized profit left at the end of the previous year.

7. Inventory TransfersExample On April 5, 2001 World Co (parent) buys 1,000 widgets from Sub, Inc. for $500,000. The widgets originally cost Sub, Inc. $400,000. At year-end on December 31, 2001, World Co. still had 250 of the units on hand. Record the consolidation entries on 12/31/01 to eliminate the unrealized gain.

8. Inventory TransfersExample { First, the entire intercompany transfer must be eliminated.

9. Inventory TransfersExample

10. Unrealized Inventory GainsEffect on Noncontrolling Interest • If the transfer is DOWNSTREAM, then any resulting unrealized gain belongs to the parent. • No effect on Noncontrolling Interest • If the transfer is UPSTREAM, then any resulting unrealized gain belongs to the subsidiary. • Noncontrolling Interest must be adjusted for the unrealized gain.

11. Unrealized Inventory GainsEffect on Noncontrolling Interest Noncontrolling Interest in Sub Net Income = the noncontrolling % of the sub’s net income, AFTER eliminating UPSTREAM unrealized intercompany profit.

12. Intercompany Land TransfersEliminating Unrealized Gains ENTRY TL If land is transferred between the parent and sub at a gain, the gain is considered unrealized and must be eliminated.

13. Intercompany Land TransfersEliminating Unrealized Gains ENTRY *GL As long as the land remains on the books of the buyer, the unrealized gain must be eliminated at the end of each fiscal period.

14. Intercompany Land TransfersEliminating Unrealized Gains ENTRY *GL (Year of sale) In the year of disposal, the unrealized gain must be eliminated one more time, and recognized in the consolidated financial statements.

15. Land TransfersExample On June 25, 2000 World Co. (parent) sells a 30 acre tract of land originally costing $600,000 to Sub, Inc. for $750,000. At year-end on December 31, 2002 Sub Inc. still owns the land. Record the appropriate consolidation entry on 12/31/02.

16. Land TransfersExample This entry must be made at the end of each year as long as the land is still on the books.

17. Intercompany Transfer of Depreciable Assets ENTRY TA In the year of transfer, the unrealized gain must be eliminated and the assets restated to original historical cost.

18. Intercompany Transfer of Depreciable Assets ENTRY ED In addition, the buyer’s depreciation is based on the inflated transfer price. The excess depreciation expense must be eliminated.

19. Intercompany Transfer of Depreciable Assets In Years Following the Year of Transfer The equipment is carried on the individual books at a different amount than on the consolidated books. These amounts change each year as depreciation is computed. To get the worksheet adjustments, compare the individual records to the consolidated records.

20. Intercompany Transfer of Depreciable Assets Big Wheel Trucking (BWT) owns 80% of Quick Delivery, Inc. On 1/1/00, Quick Delivery has a truck on the books with an original cost of $100,000, and accumulated depreciation of $60,000 (4 year remaining useful life, $0 salvage value, straight-line). Quick Delivery sells the truck to BWT for $80,000. Analyze the information in preparation for making entries on 12/31/01.

21. Intercompany Transfer of Depreciable Assets On BWT’s books, the annual depreciation = $80,000 ÷ 4 yrs. = $20,000 per year. The 1/1/01 R/E effect = the original gain of $40,000 on Quick Delivery’s books less 1 year of depreciation.

22. Intercompany Transfer of Depreciable Assets For the consolidated entity, the annual depreciation = $40,000 remaining BV ÷ 4 yrs. = $10,000 per year. The Acc. Depr. At 12/31/01 = $60,000 accumulated depreciation at 1/1/00 + 2 years of depreciation.

23. Intercompany Transfer of Depreciable Assets The consolidation worksheet adjustments appear in the last column.

24. Intercompany Transfer of Depreciable Assets ENTRY *TA (Subsequent Years) The adjustment to fixed assets and depreciation expense must be made in each succeeding period. The entry for the BWT/Quick Delivery Consolidation is:

25. Intercompany Transfer of Depreciable Assets ENTRY ED (Subsequent Years) In addition, we must adjust for the difference in Depreciation Expense on the two income statements. The entry for our example is:

26. End of Chapter 5 Hey, Chester, ol’ buddy! I’m thinkin’ we need to switch desks in a little “intercompany” transfer.